This may be attributed, in part, to the fact that no-one believes this impasse will last for long and will most likely result in some sort of agreement among the quarrelling parties. This will no doubt allow an increase in the Treasury’s capacity to issue more debt.
Every well-informed investor knows that the world’s developed economies are over-indebted. Given the accommodative policies of the leading central banks, it has become generally accepted that the debt levels are sustainable and, more importantly, are unlikely to give rise to inflation.
The markets, therefore, are generally apathetic towards the current US impasse, accepting it as political wrangling rather than a real issue of debt management.
Performance of indices over 3 months
Source: FE Analytics
The reality is that in the last six years, US national debt has risen by 82 per cent while the US national budget has grown by 340 per cent. S&P has downgraded American debt to AA+ from AAA, indicating some discomfort with economic growth slowing from 2.5 per cent in 2007 to current estimates of 1.6 per cent, while the yield on 10-year Treasury bonds has dropped from 4.6 per cent to 1.9 per cent.
It is unsurprising that the purchasing power of the US dollar has declined by approximately 10 per cent in this period when deflated by the CPI index of the US Bureau of Labor Statistics. This transformation has taken place in a period where cash injections by central banks have almost tripled and global liquidity has more than doubled.
Raising the debt ceiling is, therefore, a major issue for the Americans and it is now being used by the opposing political parties to achieve their own agenda.
It is also obvious to everyone that it is a dead-end as there are no prospects of higher economic growth in the near-term. The Fed’s recent stance now indicates an acceptance that its policies have failed to stimulate economic growth, while creating some potentially dangerous bubbles in certain asset classes.
Even though a decision to raise the debt ceiling yet again may be inevitable, it is likely that new measures will be taken to change the direction of monetary policy. It may become clearer that only by allowing further devaluation of the US dollar and a rise in inflation will debt be controlled.
Such change, when it happens, is likely to be supportive of gold as a safe haven. As investors realise that the recent positive signs of economic recovery, such as falls in unemployment and increased industrial activity in the US, were a short-term rebound from extreme lows, they are likely to seek the safety of gold as they have done historically.
Being a comparatively small market, the price of gold can be more volatile as sentiment changes. For example, the market value of GLD, one of the largest gold ETFs, is approximately 14 per cent that of Apple Inc.
Some reports indicate that the gold allocation in global portfolios is now well below 1 per cent. A small shift in strategy could have a significant effect on the gold price – the US debt ceiling debate may well prove one of the catalysts.
Performance of gold over 5yrs
Source: FE Analytics
Angelos Damaskos (pictured top of first page) is chief executive of Sector Investment Managers, and manager of the MFM Junior Oils Trust and MFM Junior Gold fund. The views expressed here are his own.